TheChek News Flow

PM signals she will change Cameron’s flagship policy if she wins

The prime minister has signalled she will scrap her predecessor David Cameron’s flagship “tax lock” policy if the Conservatives win the election, indicating that income tax and national insurance could rise.

Speaking in television interviews on Sunday, Theresa May ruled out a rise in VAT but said she did not want to make specific proposals on other taxes unless she was sure she could deliver on them.

Mrs May also hinted she would end the pensions “triple lock” — another key Cameron pledge. She said state pensions would continue to rise but added that the Tory manifesto would revisit the way this is calculated.

The Tories initially made their promises before the 2015 election, saying a tax lock would prohibit any rise in the income tax rate, VAT or national insurance, while the pensions triple lock would see the state pension rise in line with wages, inflation or by 2.5 per cent, whichever is highest.

The assurance, intended to put pressure on Labour, has become a millstone for the current government. Philip Hammond, the chancellor, was forced into an embarrassing retreat after trying to raise national insurance in this year’s Budget.

When questioned on her tax plans, Mrs May told BBC One’s Andrew Marr Show: “We have absolutely no plans to increase the level of tax but I’m also very clear that we don’t want to make specific proposals on taxes unless I’m absolutely sure that I can deliver on those.”

She added that her intention after the election would be to “reduce the taxes on working families”.

In a separate interview with ITV’s Peston on Sunday, Mrs May definitively ruled out a rise in VAT.

John McDonnell, the shadow chancellor, said it was wrong for Mrs May to drop the triple-lock formula and that he did not want to see pensioner incomes go backwards.

He also told Peston on Sunday that Labour would pledge not to raise VAT and there would be no tax rises for middle or low earners.

Earlier in the day, the prime minister also revealed plans to protect pensions from “unscrupulous” bosses.

The proposals, a response to the BHS pensions scandal, would increase the powers of the pensions regulator over company pensions and include fines for employers who “wilfully left a scheme under-resourced”.

In extreme cases, company directors could be struck off and corporate takeovers could be blocked where the solvency of the company scheme appears to be threatened.

The Tories will also consider a new law to make it illegal to intentionally or recklessly put a pension scheme at risk.

Mrs May said the plans would “ensure the pensions of ordinary working people are protected against the actions of unscrupulous company bosses”.

“Safeguarding pensions to ensure dignity in retirement is about security for families, and it’s another example of the choice in this election,” she added.

CMS, Nabarro and Olswang firms combine to fight off increasing competition

Three London law firms are combining on Monday to create a behemoth expected to pull in £1bn in annual revenues, as the legal sector consolidates to deal with increasing globalisation and pressure from new entrants.

The union of CMS UK, Nabarro and Olswang is the largest ever in the UK legal market. It is also one of more than 35 deals involving US and UK law firms announced in the first four months of this year, according to the consultancies Altman Weil and Jomati, which track legal mergers.

Senior partners and analysts say the combined firm will be the world’s sixth-largest by headcount, with about 3,400 full-time lawyers and a presence in 39 countries, and is evidence that the drive to merge shows little sign of slackening.

Law firm mergers started to gather pace in 2013, when the number of US deals shot up by nearly half to 88, and has continued at that level ever since.

The trend has caught on in the UK as leading firms seek to avoid being squeezed between bigger and more powerful players and smaller, technology-focused innovators

“The winds of change are blowing strongly” through the sector, says Peter Martyr, global chief executive of Norton Rose Fulbright. “The legal profession has been very slow to consolidate in the way predicted for a long time but in the last few years it has really taken off.”

Not only is competition from outsourcing and accounting groups increasing, but law firms are also feeling fee pressure from corporate clients, who are increasingly sending more of their legal work to fewer law firms in exchange for lower prices.

But the sector remains far less consolidated than other professional services providers, such as auditors and consultants.

“When you look at the £2bn to £2.5bn turnover of law firms and compare them to the Big Four accountancy firms, it’s clear there is a long way to go before we reach an end to consolidation,” said Crispin Passmore, executive director of policy at the UK Solicitors Regulation Authority.

These days the world’s largest law firms are almost always involved in planning, announcing or finalising some sort of deal, whether a fully fledged integration or a looser deal whereby firms share branding and strategy but keep profit pools separate.

Already in 2017, world leader Dentons, with more than 7,800 lawyers and counting, has snapped up firms in the Netherlands and Mexico; DLA Piper has acquired Danish and Portuguese outfits; while Norton Rose Fulbright is proposing to absorb New York-based Chadbourne & Parke. On February 1, UK-based Eversheds completed its merger with US firm Sutherland Asbill & Brennan less than two months after the deal was revealed.

“Traditional law firms are engaged in a battle for market share that we expect to grow in pace and intensity,” said Altman Weil in a report published this year. “The winners will be those firms with a clear and credible strategy to attract the most desirable candidates and make deals that have staying power.”

Penelope Warne, senior partner for CMS UK and a member of the integration team overseeing the merger with Nabarro and Olswang, said most big law firms were “very conservative, slightly old-fashioned organisations”, adding: “I think that clients demand that we change, and if we don’t we’re going to lose our competitive position.”

Combining the three firms’ traditional sectoral strengths — CMS for financial services and energy, Olswang in technology and media, and Nabarro in real estate — created “a powerful offering for clients”, she said. “Some firms will remain niche but all firms have to wake up to the technology issue.”

Tony Williams, head of Jomati, believes too many UK mergers have been the result of one side getting into financial trouble and needing a rescuer. “The legal sector is still very profitable despite 10 years of fairly anaemic growth [in the UK], so even when firms are not doing particularly well, if they still like their independence they don’t see the need for a merger,” he said.

“We’re not seeing enough mergers where both firms are doing it from a position of strength.”

But the 2013 merger of UK firm SJ Berwin with Australian-Chinese giant King & Wood Mallesons provides a cautionary tale. The firm created by that deal died last January when KWM’s European arm went into administration amid reports of huge debts, factionalism and a fatal exodus of top billing partners.

It was a stark reminder that mergers can carry financial and cultural risks.

“You’ve got to really understand the financials and do your due diligence,” said Mr Williams. “Are there practice synergies? Do [the firms] play in the same part of the market? Are the cultures compatible — are [they] going to work well, refer work to each other, present a united front to clients?”

Emmanuel Macron has a convincing lead in the polls, but a low turnout among his more reluctant supporters could still produce a result too close for comfort.

The final round of the French presidential election on May 7 should not really be a contest. Mr Macron has the backing of more or less the entire political establishment — from the left to the centre-right. But events can intrude even in such a situation and already have. His decision to celebrate his first-round victory in a smart brasserie in Paris’s sixth arrondissement was politically illiterate. During a visit to a Whirlpool factory in Amiens, northern France, Mr Macron was upstaged by his opponent, Marine Le Pen, leader of the far right National Front. As a political campaigner she is in a different league. If she crushes him in Wednesday’s television debate, she might have a chance.

The problem with Mr Macron’s agenda is that nobody really knows how he can make it work. The role of the French president is powerful, but the fate of François Hollande should serve as a cautionary tale of the limits of what a president can do.

Mr Hollande’s Socialists at least had a majority in the National Assembly, the French parliament. It is not clear whether Mr Macron will have a single MP after the legislative elections in June. Will he end up as a mere figurehead — like the German president — whose job is to shake hands and give grand speeches? Or can he find a way to force change?

The single most exciting promise of Mr Macron is his agenda for the eurozone. He has proposed reforms to the governance of the eurozone very much in line with what I have been suggesting in this column over the years: a common fiscal policy, a joint finance minister, a eurozone debt instrument, and completion of the banking union.

Mr Macron deserves support for this reason alone. But he owes his voters an answer to the question of what he would do if, as is likely, Germany replies to his four proposals with: nein, nein, nein and nein. Would he acquiesce or would he put pressure on Berlin? If the latter, what kind of pressure? Assuming he would not threaten a French exit from the eurozone, what else might he do? If the answer is “not much”, would we not be justified in wondering just how different a Macron presidency is going to be from that of Mr Hollande? This is precisely the point Ms Le Pen is making — that Mr Macron, a former economic counsellor to the outgoing president and a former economics minister, does not really stand for change.

At this point the nature of the choice between the two candidates would change. This would then no longer be a choice between global and provincial France. It would be a choice between an unsustainable status quo and change. If you phrase the choice this way, abstention — a choice being contemplated by many of those who voted for the far-left candidate Jean-Luc Mélenchon in the first round — suddenly becomes intellectually defensible.

In the remaining days of the campaign, therefore, Mr Macron should specify the minimum he will insist on.

On eurozone governance reforms that minimum needs to be ambitious, but realistic. He will not get Germany to sign up to his entire agenda, but a compromise may be possible.

Mr Macron will need to persuade his future German counterpart that governance reforms are in their interest too. He is probably the man best placed to do this. But Berlin has not given any official assurances yet.

If I were him, I would reduce the scope of the agenda and deepen it instead. This would involve dropping the eurobonds and fiscal integration, and focusing on banking union. Mr Macron should say that this is the minimum it will take for France to stay in the eurozone. That is still a pro-European position, even though it includes an implicit threat. It is credible because it addresses the eurozone’s most fundamental problem.

What we have today is not a real banking union. You can speak of a banking union when banks no longer hold the sovereign bonds of their governments, and when a government is no longer in a position to stop the closure of a domestic bank. Banking union means that you take the nation state out of banking.

In such a union, the Germans would get a much stronger no-bail out commitment. If the financial system is ringfenced, there is no reason why member states should not default on their sovereign debt.

If Mr Macron succeeds, we would have reason to be optimistic about the future of the EU. But if the promise of a new direction turns out merely to be a reaffirmation of the old dispensation, we should expect to see a President Le Pen, if not this year, then in 2022. By then, the French will have tried everything else.

“I had a conversation in December with a major hedge fund manager in New York,” recalls Paul Wick, the dean of technology investing, who runs the $5 billion Columbia Seligman Communications & Information fund. “I asked him why he didn’t own semiconductor stocks. He said, ‘I don’t understand that business, and I’m hesitant to trust other people, even if I hire them.’ ”

The 54-year-old manager adds, with evident glee, “Pretty much the whole East Coast hedge fund mafia has missed what has gone on in the semiconductor industry in the past five years,” during which the Philadelphia Semiconductor Index rose 146%.

Wick’s detail-oriented analysis and deep understanding of tech—he’s run the C and I fund (ticker: SLMCX) for 27 years—has served his investors well. Over the past 10 years, it’s posted an average annual return of 11.7%, compared with 9.3% for its peers and 6.9% for the Standard & Poor’s 500 index. And his contrarian view of the internet bubble in the late 1990s spared his investors from the tech crash.

These days, Wick thinks technology stocks are anything but in a bubble. Fundamentals appear to be in excellent shape, he says, and the future has rarely seemed brighter.

Barron’s: How’s the tech market looking these days?

Wick:Think about it: How many companies have preannounced negatively for the March quarter? I can’t think of any. In general, things have been going swimmingly well for the tech sector, going back even to the December quarter. I think most segments have been doing pretty well fundamentally, including software and semis. In the internet sector, companies such as Priceline Group [PCLN] and Facebook [FB] have done remarkably well.

What’s working in their favor?

In terms of demand, a lot of good things are happening. These large cloud-data centers, [built] to accommodate streaming and e-commerce, have to keep adding capacity to satisfy customers, and have to maintain good security. So it’s been a very positive overall picture for technology. Think of how tech has done the past 15 years since the bubble reached its nadir. We came back pretty strongly. Infotech now makes up 22% of the S&P 500. So, we are on a steady march upward. It hasn’t been a jump-up like the late ’90s. It’s been very gradual, which is very comforting to me as an investor.

What about all the headlines about legacy tech crumbling under the weight of the cloud, and smartphone sales slowing?

A lot of that’s just a fallacy. These data centers require lots of storage, which means lots of solid-state drives. They are replacing disk drives, but even the SSDs frequently have to be replaced because they have only so many write-and-erase cycles before they become less reliable.

You could say smartphones are becoming boring. Well, true, the overall unit growth has, but the average phone is getting more expensive, so the dollar content of chips in those devices keeps going up. You’re getting more memory per phone, better Wi-Fi capability, and biometrics, or 3-D sensing—just a lot of stuff. All that content is not slowing down, even though unit volumes aren’t growing that much. There are lot of very positive trends in all that.

Chip prices have been rising, but investors always are concerned that chip supply will increase rapidly and destroy pricing. Is that a worry now?

What I’d say is that the industry’s consolidation has made companies more profitable, a bit like the airline industry. And Moore’s Law is slowing down, so the leading-edge chips are no longer getting cheaper. In many cases, they are getting more expensive. That’s a new industry dynamic, and it’s very positive for the semiconductor industry.

One thing that bears watching is Samsung Electronics (005930.Korea). They seem to have changed their management philosophy. They are more focused on profit now than on market share or killing off competitors.

So, the death of Moore’s Law is good, not bad, for chip makers?

Yes, it’s very good for the overall chip industry. Costs are going up, and chip prices are going up. Look at Intel [INTC]. The average price of its processors has gone up over the last five or six years. Nvidia (NVDA) is another example where prices have ticked up. Broadcom (AVGO) as well, with its high-end network processors. We are in somewhat of a new era, and chip stocks are still cheap, relative to industrial stocks. One thing we grasped, that maybe some others didn’t, is that you could play cloud computing and the Internet of Things, and other trends, through semiconductor stocks, and get more bang for the buck than you get from internet stocks and software stocks.

What do you like these days?

Our favorite and largest position is [chip equipment maker] Lam Research [LRCX]. It had exceptionally strong results last quarter. Lam grew revenue at around 60%, year over year, which is pretty heady growth for a supposedly mature business. The company’s profit margins are at record levels, and they are generating a lot of cash.

Who else do you like in chips?

We’re big fans of the memory industry, including Western Digital [WDC] and Micron Technology [MU]. If you think back to when Micron was doing well [in 2014], and the stock price got into the $30s, the company was making about $3 annually in EPS. Now, Micron stock is in the mid-$20s, and the earnings run rate is on the order of $5 or $6 annually. If anything, it looks like fundamentals now are more enduring.

What about the persistent fear that the memory business leaps to overcapacity every now and then? That’s what brought down Micron stock in 2015.

The key thing is that there has been a change in behavior throughout the industry. There is a new caution about capital spending for DRAM [dynamic random access memory], for example, and there is Samsung’s newfound emphasis on profitability. There is not enough new capacity going into the market to upset the apple cart in DRAM anytime soon. There’s another thing that gets to the heart of why Micron is a better story now than it was 15 or 20 years go. In the ’90s, the stock had a meteoric run that was almost entirely driven by the personal computer. DRAM was a commodity. PC makers could swap out a part and replace it with another manufacturer’s part.

Fast forward to now: DRAM for PCs is a fairly small percentage of the industry’s DRAM revenue, and increasingly, those parts can’t be simply swapped out; each device requires different speed interfaces. So memory is a better business, with fewer players, and with parts that are more differentiated. As a result, DRAM price swings will be less. On the NAND flash side of the business, with the move to 3-D [chips], gross profit margins are going up. They went from 20% to 30%. It’s tough to say what the peak may be, but it will go up into the 40s.

In a 2015 cover story, we said Micron could be one of the most important chip makers because of the rise in things like machine learning, requiring large amounts of memory in computers.

The demand is definitely there. These automotive ADAS systems [advanced driver assistance systems]—some of those vehicles have 24 gigabytes of DRAM! Think about cloud computing, artificial intelligence, machine learning—in all of them, the most important element is cheap memory, and huge quantities of it. Demand will be there.

Tell me more about Western Digital.

Western has two aspects to it; one is the hard-drive business. The simplistic view is that hard drives go away as NAND flash becomes prevalent. But the reality is that data in aggregate is growing at 35% annually. With data growth, and with the drive guys not adding capacity, Western and Seagate Technology [STX] keep getting better pricing. And Western has the best margin structure in NAND among all vendors. The consensus earnings number is $8.09 this fiscal year, ending in June, but we think it will be much higher than that. The consensus for fiscal 2018 is $9.47, and then $9.60 in fiscal 2019. We think those are too low as well.

What don’t you like?

The first and easiest dog we see is IBM [IBM]. IBM is a company that has been pulling rabbits out of the hat for the past decade, and that is running out of rabbits. Just look at the results. They have benefited from lower taxes and nonrecurring intellectual-property revenue. In calendar 2016, they made a noncash contribution of over $500 million to their pension fund, which was really equivalent to an outflow of cash-equivalent securities, and somehow found a way not to consider that a use of cash. So, even the free-cash-flow numbers are overstated. They have now had 20 straight quarters of declining sales. That’s going to continue. It is a melting ice cube, and a big-time victim of the move to the cloud.

What’s next on your list?

I’d be so bold as to say Tesla Motors [TSLA] and Netflix [NFLX] are the two most extravagantly overvalued, large-cap companies in tech. For whatever reason, Tesla convinces people it doesn’t matter that it will burn $5 billion in cash. And Solar City was a horrible acquisition. The notion that it will sell 400,000 or 500,000 Model 3 cars in a very short period, and turn profitable, defies logic. I think the competition is very good, and inevitably will catch up. They are going to continue to have to raise money, given how much cash they are burning. The amazing thing is the stock rallied so hard with the last capital raise—because they didn’t raise as much as feared. All they did was postpone the day of reckoning. If rates ever do move substantially higher, that could be ominous for Tesla.

What’s your beef with Netflix?

With Netflix, the market cap is about $65 billion. They said in their press release a couple of weeks ago that they plan to burn cash to accompany rapid growth for many years. They have been free-cash-flow negative in a material way for four years now. They burned $1.7 billion last year, and it looks like they’ll burn about $2 billion this year. They have to keep raising debt.

The idea is one of constantly spending more and more on content, but spending on content is going to bring in fewer and fewer subscribers. The content spend keeps going up, and they are bringing in roughly the same amount of new subscribers—or slightly less. Growth is slowing. They are amortizing their content spend over four years. Amazon.com [AMZN] amortizes pretty much instantaneously, as its shows are released. One could argue that Netflix is overstating its earnings. Maybe people don’t care, but that seems pretty obvious to me. Tesla and Netflix are cases of the greater fool theory.

Netflix will become kind of like HBO, which has its own subscribers and content. What does the market pay for those types of media assets? It’s never more than 10 to 15 times Ebitda [earnings before interest, taxes, depreciation, and amortization] compared with 66 for Netflix. I don’t see Disney (DIS), Apple (AAPL), or Alphabet (GOOGL) buying them. There aren’t many $65 billion-plus deals that happen; it would be so dilutive. It isn’t a monopoly business; the company is cash-flow negative. These types of stories don’t go on forever.

Thanks, Paul.

Iran Signals It Is Prepared to Extend Oil-Production Cap

Oil minister’s comments come less than a month before OPEC officials meet in Vienna

TEHRAN—Iran signaled its readiness to cap its oil output until the end of the year in order to extend an OPEC-led agreement to cut production, backing Saudi Arabia’s push to raise prices.

Despite wanting to boost output, Petroleum Minister Bijan Zanganeh said Saturday that Iran has kept its oil production at 3.8 million barrels a day under an agreement brokered last year by the Organization of the Petroleum Exporting Countries and joined by some critical non-OPEC members including Russia.

Saudi Arabia has told OPEC officials that it wants to extend the cartel’s agreement to cut crude-oil production for another six months when the group meets on May 25 in Vienna. OPEC member Iran, which was allowed to limit rather than reduce its output under the deal, was seen as a potential obstacle.

There have been positive signals that the oil exporters would support the Saudi proposal, Mr. Zanganeh said.

Separately, Tehran’s oil chief accused Washington of preventing energy investments in Iran, saying major oil-and-gas firms with sizable investments in the U.S. were concerned by American retribution and have stayed away.

Since Iran and world powers in 2015 agreed on curbing the country’s nuclear program in exchange for the lifting of international sanctions, many global energy firms have been eager to enter one of the world’s biggest oil-and-gas markets.

But while Western companies from industries including automotive and aviation have completed deals in Iran, the country has yet to ink a major energy deal.

“The major thing is the political limitation for them and pressure on them in the United States,” Mr. Zanganeh said on the sidelines of meetings among Iranian and European Union officials in Tehran. He dismissed concerns about financing and continued U.S. sanctions against Iranian banks, which energy firms cite as leading reasons for holding out on the lucrative market.

Iran developed its South Pars gas field despite sanctions, he said, adding that the Trump administration might be able to slow investments but would ultimately fail to curb growth in the oil-and-gas industry—a key driver of the country’s economy.

European and Asian firms have poured into Iran since sanctions were lifted. American companies, however, have largely held back, unsure about whether President Donald Trump—a sharp critic of the nuclear deal on the campaign trail—would try to alter the pact or otherwise discourage closer business ties.